Australia's main official cost of living measure, the consumer price index, is failing young Australians by excluding home purchase costs, argues an economist from Australia's largest bank.

The consumer price index (CPI) produced by the Bureau of Statistics measures the price changes in a basket of goods to determine whether the cost of living is rising or falling, and by how much.

It is a critical ingredient in economic policy and business, with many government payments and private contracts indexed to CPI, and monetary policy set to target CPI inflation of between 2-3 per cent per annum.

However, Commonwealth Bank senior economist Gareth Aird said there is a "massive flaw" in CPI as a cost of living measure.

"The index ignores price changes in the single biggest purchase a person (or household) is likely to make in their lifetime – a dwelling," he wrote in a note.

"For households that do not own a dwelling and aspire to purchase one, the CPI is a very poor measure of changes in the cost of living."

There has been a massive difference in the increase in the cost of existing homes, mainly due to rising land prices, and the increase in other costs of living.

Since 1998 national dwelling prices have roughly quadrupled, while consumer price inflation was just 63 per cent. Over the past four years, dwelling prices rose 44 per cent, while other consumer prices rose just 8 per cent.

To illustrate the difference to the cost of living that including the purchase of an existing home would make, Mr Aird constructed an index that included home purchase costs with a 10 per cent weighting in the CPI basket.

He found that overall CPI would have been an average of 0.55 percentage points higher including home purchase, which would have seen far less pressure on the Reserve Bank for lower interest rates, one of the factors which has worked to boost home prices.

Home price exclusion 'masks' intergenerational inequity

The Bureau of Statistics has considered in the past whether to include home prices in the CPI, but decided against it because it has a "a significant savings or investment component" - in other words, existing owners actually derive benefit from rising home prices, rather than feeling them as an increased cost of living.

However, Mr Aird said this argument does not ring true for first home buyers.

"For aspiring home owners dwelling prices are part of the inflation that they face," he posited.

"Their exclusion from the CPI therefore makes it an inaccurate measure of the type of living costs that they face."

The Reserve Bank also supports excluding home purchase costs from CPI.

"The purchase of existing housing represents a transfer within the household sector (which means that there is zero net expenditure by the household sector in these transactions)," the RBA has argued.

But Mr Aird countered that "rent is also effectively a transfer within the household sector from tenant to landlord and rent is included in the CPI."

While not arguing for dwelling prices to be included in CPI, Mr Aird said it has masked the cost of living increase for aspiring first home buyers.

"For them, the cost of living has risen by more than is implied by the CPI," he observed.

"This is, to an extent, very much a question of generational equity.

"Real wages growth has generally been positive over the past five years despite falling nominal wages growth as CPI inflation has been trending down. But if we deflate nominal wages growth by a measure of inflation that includes dwelling prices (i.e. CPIH) the picture looks quite different.

"Deflating wages growth by CPIH more accurately captures real wage changes for those who aspire to own a home. These individuals (or households) are generally below 35 [years old]."

On this broader measure of CPI, the real wages of aspiring home owners are currently falling, and have done several times over the past two decades.

Skewed CPI data leads to 'huge debt hangover'

In addition to the issue of intergenerational inequity, Mr Aird argued that the exclusion of dwelling prices from CPI has been a contributor to lower interest rates and a dangerous rise in household debt levels.

"The hangover in Australia from pushing interest rates lower over an extended period of time to hit an inflation target has been a huge accumulation of debt and very high dwelling prices," he noted.

Mr Aird also pointed out the economic contradiction of excluding the very price most directly affected by interest rate changes from the index on which rate decisions are based.

"Lowering (raising) interest rates has an immediate positive (negative) impact on the price of the very thing not included in the CPI – dwelling prices," he observed.

Thus, including home prices in CPI would actually assist the transmission of monetary policy through to the inflation target more quickly.